The government and parliament that emerge from Luxembourg’s general election on October 8 will have to tackle numerous legislative and other matters of central importance to Luxembourg’s financial industry and in particular the fund sector, Europe’s largest. The most important issues for the sector that politicians should address include the demand for skills, rules on cross-border commuters, defending the outsourcing model and complex SPV structures, and improving access to banking services.
As Luxembourg’s political parties gear up for the country’s general election on October 8, many of the most intense policy discussion will deal with issues such as housing costs, health provision, the cost of living and salary indexation, protection of the environment and traffic congestion.
In general, financial sector development and regulation is likely to figure low on the scale of priorities for the candidates who aspire to be members of the next government or parliament. But it is a vital policy area nonetheless, given that the financial services sector is one of Luxembourg’s largest providers of employment, and directly and indirectly contributes the most of any sector to the government’s tax resources.
Legislation: maintaining a rapid response
The Luxembourg fund industry, increasingly including alternatives such as real estate, infrastructure, private equity and private debt, has a major impact on the country’s overall wealth. Luxembourg funds held nearly €5.14 trillion in assets at the end of May 2023, more than any country worldwide except the United States, with the aggregate assets of alternative investment funds domiciled in the grand duchy totalling €1.48trn at the end of 2021, according to the CSSF.
That’s in large part down to the acuity of political authorities in the past in seizing opportunities to expand and diversify Luxembourg’s economy, notably ensuring that it was the first EU member state to adopt the original UCITS directive into national law – paving the way for its primacy as a fund domicile and servicing hub.
Since then successive governments have created the regulatory structures and fund vehicles to make the grand duchy a leading jurisdiction for alternative investment funds, including speedy adoption of the Alternative Investment Fund Managers Directive and legislation on SICARs, Specialised Investment Funds, limited partnerships and Reserved Alternative Investment Funds.
Human resources: attracting skilled staff
The authorities have also overseen the evolution of financial regulator CSSF to conduct effective oversight of the growing industry and encouraged a flexible and business-friendly approach to supervision.
But today there are fresh challenges to face. Although the financial industry is a major employer offering high salaries, it is struggling to attract all the skilled staff it needs, even drawing on a talent pool encompassing neighbouring regions of Belgium, France and Germany. The result is a wage-cost spiral exacerbated over the past two years by higher overall inflation.
Day-to-day pressure on skills and recruitment is also a distraction from the long-term need for the government, industry organisations and institutions such as the University of Luxembourg, assisted by the CSSF, to establish a comprehensive human resources plan, involving training and education to attract and develop new talent, university graduates and job-changers, assisted by greater flexibility on remuneration and working conditions.
Tax and social security: complicating employment
An additional complication are the tax and social security rules applicable to the large number of cross-border commuter employed in Luxembourg’s financial sector. Restrictions on working from home were relaxed at the onset of the Covid-19 pandemic, but have now been restored.
Although in several areas the teleworking limits have been expanded, non-residents remain restricted in the number of days a year they can work from home without become subject to income tax in their country of residence.
A comprehensive solution to address these issues, ideally through harmonisation of bilateral agreements with Luxembourg’s neighbouring countries, would make the situation more straightforward both for companies in the grand duchy and their non-resident staff, as well as national social security and tax authorities.
Meanwhile, the recent surge in the cost of living affects employees in the financial industry as well as other sectors. Although inflation appears to be easing, falling back to an annual rate of 3.2% in June, the ongoing rise in interest rates is an added burden on homeowners.
Other countries have offered direct help: Spanish banks have moved to suspend annual mortgage rate reviews, and the government has introduced rent controls and assistance for young and first-time-buyers. Similar assistance in Luxembourg would have added benefits for the country; affordable housing helps attract and retain local and international staff with the technological, digital and financial expertise the industry needs.
Outsourcing, offshoring and substance
One answer to skills shortages is outsourcing of some key functions – a core element of Luxembourg’s DNA, which has built up an ecosystem of specialist service providers to the fund industry. For example, the use of third-party providers for fund administration and related services, including reporting, has long overtaken in-house services.
The strength of this model is recognised by the CSSF, which last year issued an updated framework for outsourcing arrangements, including those relating to information and communications technology. The industry would like to see an increase in resources for the regulator to enable it to speed up authorisation of providers of critical services, where increased demand has slowed response times.
Offshoring may or may not involve outsourcing, but drawing on staff and resources outside Luxembourg. This raises issues of oversight both for fund board members who bear the ultimate responsibility for regulatory compliance, and for the CSSF.
Oversight of fund functions outsourced to providers outside the EU has been a concern of some member states that have called for a greater supervisory role for the European Securities and Markets Authority. This has been largely pushed back, not least because of the proven benefits of the outsourcing model over many years, but the industry is facing greater scrutiny over substance in terms of activities and people in the fund’s home jurisdiction – driven by broader concerns about aggressive tax planning.
SPVs: avoiding unfair disadvantage
This issue is of particular concern to Luxembourg’s alternative fund sector because of the use of Special Purpose Vehicles to gather and hold assets, often from many different countries, as part of the fund’s investment strategy. As we have noted previously, this model has nothing to do with abusive tax avoidance.
The EU’s third Anti-Tax Avoidance Directive, dubbed 'Unshell' because it aims to curb improper use of so-called shell companies, remains under debate at European level but could potentially have negative consequences for Luxembourg alternative funds that use intermediate entities within cross-border structures.
Luxembourg’s political authorities need to follow this debate closely and ensure that limits, exemptions and thresholds relating to where income is sourced for tax purposes should not unfairly disadvantage the country’s funds and their investors. Otherwise, there is a risk that alternative fund managers may choose other jurisdictions for their funds and investment structures - causing economic damage not just to this country but to the EU as a whole.
A recent European Court of Justice ruling has reopened the debate on access rights to data on ultimate beneficial ownership of companies in Luxembourg’s Register of Beneficial Owners, and by implication those in other EU countries. The next government should work with the financial services industry and other member states to ensure that the rules maintain transparency while reducing companies’ administrative and cost burdens.
Bank accounts: easier access
We are pleased to see that a long-standing concern, banks’ reluctance to provide account services for members of the financial services industry, is now being addressed. A recent initiative by the ABBL, the Chamber of Commerce’s House of Entrepreneurship and the CSSF aims to encourage banks to provide account services for entities such as funds and holding companies, including proposals for improved compliance training and upskilling.
We acknowledge the importance of measures to curb money laundering and the financing of terrorism, but the time and complexity involved in opening accounts risks eroding Luxembourg’s competitiveness as a funds hub. Part of the solution should involve greater readiness by the CSSF to accept use of digital banks, electronic money institutions and payment institutions, many of which offer innovative digital verification services.
There is also a broader need for government members and officials, the CSSF and the banking sector to collaborate on the introduction of artificial intelligence and other innovative services, for instance to ensure that AML processes can be conducted without damaging delay and disruption. The CSSF has already announced an initiative to reduce reporting costs through the development of application programming interfaces.
L3A has established working groups on many of these issues – as part of our efforts to find practical solutions that meet political imperatives but ease the burden on Luxembourg’s fund industry. We hope the country’s political parties will think about their importance in the run-up to the election and that the next government is ready to act rapidly to ensure that the sector remains competitive and a critical source of employment, revenue and national prosperity.